8 Fund Types To Use In A Recession

The herd instinct kicks into overdrive when mutual fund investors hear

the word recession and news reports show stock prices dropping. Fears

of further declines and mounting losses chase investors out of stock

funds and push them toward bond funds in a flight to safety. It’s an

effective tactic for investors who are seeking to avoid risk and are

smart or lucky enough to sell while their portfolios are still on the

positive side — but it’s not the only strategy available to combat

tough times. Read on for a look at bond funds that tend to outperform

in tough market conditions.

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1. Federal Government Bond Funds

There are several types of bond funds that are particularly popular

with risk-averse investors. Funds made up of U.S. Treasury bonds

lead the pack, as they are considered to be one of the safest.

Investors face no credit risk because the government’s ability to

levy taxes and print money eliminates the risk of default and provides

principal protection.

Bond funds that invest in mortgages securitized by the Government

National Mortgage Association (Ginnie Mae) are also backed by the full

faith and credit of the U.S. government. Most of the mortgages

(typically mortgages for first-time homebuyers and low-income

borrowers) securitized as Ginnie Mae mortgage-backed securities

(MBS) are those guaranteed by the Federal Housing Administration

(FHA), Veterans Affairs or other federal housing agencies.

*2. Municipal Bond Funds*Next on the list are municipal bond funds.

Issued by state and local governments, these investments leverage

local taxing authority to provide a high degree of safety and security

to investors. They carry a greater risk than funds that invest in

4. Money Market Funds

When it comes to avoiding recessions, bonds are certainly popular, but

they aren’t the only game in town. Ultra-conservative investors and

unsophisticated investors often stash their cash in money market

funds. While these funds do provide a high degree of safety, they

should only be used for short-term investment.

*5. Dividend Funds*Contrary to popular belief, seeking shelter during

tough times doesn’t necessarily mean abandoning the stock market

altogether. While investors stereotypically think of the stock market

as a vehicle for growth, share price appreciation isn’t the only game

in town when it comes to making money in the stock market. For

example, mutual funds that focus on dividends can provide strong

returns with less volatility than funds that focus strictly on growth.

*6. Utilities-Based Mutual Funds*Utilities-based mutual funds and

funds that invest in consumer staples are less aggressive stock fund

strategies that tend to focus on investing in companies that pay

predictable dividends.

*7. Large-Cap Funds*Traditionally, funds that invest in large-cap

stocks tend to be less vulnerable than those that invest in small-cap

stocks, as larger companies are generally better positioned to endure

tough times. Shifting assets from funds that invest in smaller, more

aggressive companies to those that bet on blue chips provides a way to

cushion your portfolio against market declines without fleeing the

stock market altogether.

8. Hedge Funds and Foul Weather Funds

For wealthier individuals, investing a portion of your portfolio in

hedge funds is one idea. Hedge funds are designed to make money

regardless of market conditions. Investing in a foul weather fund is

another idea, as these funds are specifically designed to make money

when the markets are in decline.

In both cases, these funds should only represent a small percentage of

your total holdings. In the case of hedge funds, hedging is actually

the practice of attempting to reduce risk, but the actual goal of

most hedge funds today is to maximize return on investment. The name

is mostly historical, as the first hedge funds tried to hedge against

the downside risk of a bear market by shorting the market (mutual

funds generally can’t enter into short positions as one of their

primary goals). Hedge funds typically use dozens of different

strategies, so it isn’t accurate to say that hedge funds just hedge

risk. In fact, because hedge fund managers make speculative

investments, these funds can carry more risk than the overall market.

In the case of foul weather funds, your portfolio may not fare well

when times are good.

Diversification: A Strategy for Any Market

While bond funds and similarly conservative investments have shown

their value as safe havens during tough times, investing like a

lemming isn’t the right strategy for investors seeking long-term

growth. Trying to time the market by selling your stock funds before

they lose money and using the proceeds to buy bond funds or other

conservative investments and then doing the reverse just in time to

capture the profits when the stock market rises is a risky game to

play. The odds of making the right move are stacked against you. Even

if you achieve success once, the odds of repeating that win over and

over again throughout a lifetime of investing simply aren’t in your